Square earnings: Amid CFO's exit, confidence boost is needed

Square Inc. remains one of tech’s highest fliers this year, but shares have taken a beating recently amid economic concerns and the impending departure of the company’s very visible chief financial officer.

That puts even more pressure on the company’s third-quarter earnings report, which is expected Wednesday after the market closes. Square

shares are off 22% from their late September closing high and investors will be looking for reassurance about the resilience of the company’s lending business and about the transition that will take place once CFO Sarah Friar steps down from her post at the end of the year. .

Investors worried about a potential economic slowdown have fretted about Square, since small businesses — the core of Square’s customer base — are considered especially vulnerable in a downturn. In addition to processing payments for small enterprises, Square also lends to them, exposing the company to some credit risk. It recently announced an extension of that credit program, which will provide consumer loans for certain big-ticket purchases.

Square Capital, the segment that facilitates this lending, is a fast-growing area of Square’s business but one that’s also hotly debated on Wall Street. The company has maintained that it sees minimal balance-sheet risk from business lending, but management will likely face more questions on the subject during Square’s earnings conference call.

The call will be the last to feature Friar, who announced earlier this fall that she will leave the company at the end of the year to become chief executive of Nextdoor Inc., a social network for neighborhoods. Friar has been hailed by one analyst as a “rock star” chief financial officer, and she is considered to be a driving force behind Square’s recent successful initiatives, especially given that Chief Executive Jack Dorsey spends half his time dealing with Twitter Inc.

“We contend replacing Sarah is not possible, particularly considering how early she joined Square,” SunTrust Robinson Humphrey analyst Andrew Jeffrey wrote last month. He viewed Friar’s role as “the bridge between unbridled R&D enthusiasm and sound [return on investment]-based capital allocation and investor sentiment management.” Jeffrey, who rates the stock at hold with a $74 target, said that in that sense, Friar was more of a chief executive officer or chief operating officer for Square than she was a CFO.

Analysts will likely press Dorsey on the transition plan, the CFO search and the qualities that Square is most focused on while looking for signs of continued momentum in the company’s high-margin services businesses.

Deutsche Bank analyst Bryan Keane expects that since Friar is staying on through the end of the year, Square might issue a preliminary forecast for 2019. He expects an outlook of 40% to 43% growth in adjusted revenue. He rates the stock a buy with a price target of $98.

Morgan Stanley’s James Faucette will also be closely watching for comments about next year.

“We think Square could see more stock-specific movement post earnings than most of the payments names (most other than First Data Corp.

have seen post-results moves be dictated by broader market moves), with the ultimate trajectory of the stock likely determined by commentary around 2019 margin expansion,” wrote Faucette, who rates the stock at equal weight with a $75 target.

What to expect

Earnings: Square said in conjunction with its last earnings report that it expected 8 cents to 10 cents in adjusted earnings per share. Analysts surveyed by FactSet expect that Square earned an adjusted 11 cents per share for the third quarter, up from 7 cents a year earlier. According to Estimize, which crowdsources estimates from hedge funds, academics, and others, the average projection calls for 13 cents a share in adjusted earnings.

Revenue: Analysts tracked by FactSet project $863.4 million in third-quarter revenue, while the average projection on Estimize calls for $872 million. Square generated $585.2 million a year earlier. The company forecast revenue of $840 million to $860 million in its last shareholder letter.

The FactSet consensus calls for $414 million in adjusted revenue, which is net of transaction costs and bitcoin

Of the 36 analysts tracked by FactSet who cover Square, 15 have buy ratings on the stock, 18 have hold ratings and three have sell ratings. The average target price is $83.65, 8% above current levels.

What else to watch for

Square’s Cash product will likely remain a focus in the current quarter. Management may be pressed on user momentum and monetization efforts, including Instant Deposits, the Cash debit card and bitcoin trading.

The company might also expand on Friar’s remarks from a September conference, during which she suggested that the Cash app might eventually take on more banklike functions.

“Anything you do today with a bank account, you should look to Cash app to begin to emulate more and more of that,” Friar said at the Code Commerce event. Analysts may ask the company for more information about these plans or to detail the long-term goals of Cash.

Friar also spoke in September of Square’s objective to attract “the biggest businesses in the world” to its platform. The move upmarket has been a successful part of Square’s strategy thus far, and investors will be paying attention to what portion of Square’s business comes from sellers doing more than $125,000 a year in gross payment volume. Half of Square’s business came from these merchants last quarter, the company said, up from in prior periods.

The company recently introduced a new terminal product that executives said could help with the move upmarket, and management may share thoughts on the early traction for the Terminal.

Also of interest to investors will be Square’s various high-margin services offerings. The various subscription businesses seem to be the “primary upside contributor” to Faucette’s expectation for $411 million in adjusted revenue, “as has been the case the past three quarterly reports.”